The right-leaning Centre for Policy Studies think tank has warned UK local authority pension schemes are heading into a “death spiral”, saying they should merge and slash costs before they implode.

Michael Johnson, research fellow at CPS, said: “The active fund management business is a web of meaningless terminology, pseudo-science and sales patter", and schemes should use passive styles, including exchange-traded funds, managed in-house.

He added: “Costs are controllable whereas investment performance, by and large, is not.” He said mergers and the sacking of active managers would cut total costs by £860 million. In-house managers would no longer require the services of consultants, he said, except to check their efficiency.

Johnson started his career as a credit analyst at JP Morgan and later worked for actuarial consultant Towers Watson. He went on to act as secretary to the Conservative Party’s Economic Competitiveness Policy Group, which has informed the thinking of Chancellor George Osborne.

The CPS, chaired by Lord Maurice Saatchi, was founded by the late-Prime Minister Margaret Thatcher and Sir Keith Joseph in 1974. It continues to identify with many Conservative Party values.

A CPS study produced by Johnson this year said pension tax incentives worth £360 billion over the last decade were a waste of money because they mainly benefited the wealthy and failed to encourage a savings culture.

Johnson has analysed accounts published by local authority pension schemes across Britain and found little correlation between the amount of money spent and the performance their schemes generated.

He analysed the impact of private equity exposures totalling £9 billion on different schemes. He calls it: “An extraordinary exhibition of profligacy and missed opportunity.” He said any scheme wishing to access private equity should do so using one team of in-house managers servicing all the LGPS funds, adding that exposures to fund-of-fund structures should be terminated forthwith.

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Johnson noted local authority schemes in England and Wales were only 77% funded. He said the government could take over council pension promises at some point, as it has done with the Royal Mail pension scheme, although he warned against using their assets to reduce the national debt because long-term investment returns would be valuable.

Alternatively, the government could consider underpinning schemes by guaranteeing liabilities and making schemes eligible for entry into the Pension Protection Fund, the state lifeboat.

Johnson said some schemes are using discount rates to calculate liabilities which were too flattering. He demanded a more realistic standard approach.

He said scheme mergers could be ordered by the government, facilitated by cross-scheme collaborations or encouraged through a benchmarking approach which would highlight the inevitable benefits of scale, as has happened in Australia. The idea of council scheme mergers has also been championed by the London Pensions Scheme Authority, chaired by Edi Truell.

But Andrew Kirton, head of Mercer’s investment business in Europe, expressed doubts over the report: “The obsession with ‘merger’ and ‘consolidation’ is missing the point. Whilst some of the smaller funds appear to struggle to achieve economies of scale, they are very much in the minority.

“This is particularly so if local authorities followed the CPS recommendation to go passive. A £2 billion fund can achieve pretty much the same fee rates for passive management as a £20 billion scheme."

He added: “There are some good ideas. I just wish the government and its supporters could see that consolidation is not a silver bullet. "

-- write to mfoster@efinancialnews.com

-This story has been updated to correct one misspelling of Michael Johnson's surname.